In this paper we examine the portfolios of more than 40,000 equity investment accounts from a large discount brokerage during a six year period (1991-96) in recent U.S. capital market history. Using the historical performance for the equities in these accounts, we find that a vast majority of investors in our sample are under-diversified. Even accounting for the likelihood we have selected on speculators, the magnitude of the diosyncratic risk taken by investors in our sample is surprising. Investors are aware of the benefits of diversification but they appear to adopt a 'naive' diversification strategy where they form portfolios without giving proper consideration to the correlations among the stocks. Over time, the degree of diversification among investor portfolios has improved but these improvements result primarily from changes in the correlation structure of the US equity market. Cross-sectional variations in diversification across demographic groups suggest that investors in low income and non-professional categories hold the least diversified portfolios. In addition, we find that young, active investors are over-focused and hold under-diversified portfolios. Overall, our results indicate that investors realize the benefits of diversification but they face a daunting task of 'implementing' and maintaining a well-diversified portfolio.

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